WHY DO INVESTORS STILL NOT UNDERSTAND BONDS?

When the stock market volatility is not doing you any favours and when the banks are screwing you for every penny saved that you have worked so hard for, it makes you wonder why investors still fail to recognise the obvious sanctuary of fixed income investments. I mean, just think about it for a second. The stock market has been booming for a decade since the collapse in 2008 and the low in equity prices globally around March 2009. Since then we have seen this unprecedented run which many would argue has been nothing short of magical. Even the Brexit vote and subsequent turmoil and mayhem has not been able to take this bull run off track. Not even the untimely exit of the nation’s new waist-coat wearing, favourite Gareth Southgate and his boys from the World Cup has dampened the mood. But like all good parties, they do eventually have to finish even though nobody wants them to. You may not even care that you are the last one shaking your booty on the dance floor despite the music having already stopped and after everybody else has gone home, but you should care. That’s because when the music stops the people left in the room are the ones who have to pick up the pieces and tidy up all the mess. That’s how I see it. And even if I have a mild form of OCD for cleaning (yes that’s true) I still don’t particularly enjoy the act of cleaning. The point is this. The market has been on an absolute behemoth run that most people haven’t expected but with Quantitative Easing now being tapered in Europe, political instability in the UK, and trade protectionist policies likely to impact global trade, there will be a slow down at some point. In fact, it’s happening already. If you invest in the big blue-chip stocks in the UK, it will not have escaped your notice that they haven’t been looking too clever recently. Take the likes of Vodafone or SSE, both huge companies, safe companies supposedly with fantastic dividends. Both have fallen sharply in recent months and some would argue look set to continue. That’s not to say that you shouldn’t be investing in them. If you are a long-term buy and hold investor and looking just for the dividend I am pretty sure that in the long term they should eventually recover and so buying now is maybe not an issue for you. However, at the same time there is no getting away from the fact that the meteoric rise of the past 10 years is well and truly behind us and the risk of investing heavily in shares is now significantly higher than before which is why diversifying into other asset classes makes a lot sense. It’s clear I am sure you will agree that the stock market is slowing down. So, with all that said, why isn’t it then that investors are not actively looking for other investment vehicles? I mean, it’s not as if they are spoiled for choice or the range of options is so extensive that it’s hard to know what to choose. Apart from property there are only 3 places that you can put your money 1) Cash2) Bonds3) Equities So, if equities are already slowing down and more likely to be slowing down over the next 12-18 month, and cash is being suffocated by the silent assassin that is inflation, then it doesn’t take a rocket scientist to work out that bonds is probably the only option left on the table. I don’t wish to sound patronising or condescending but it’s important that I break this down into simple terms because that’s what it is – simple. Which takes me to my next point. If bonds are the only option left on the table why is it the one that is most readily shunned. Well I have thought about this and did some research on my own clients and what I have found is this. Investors don’t buy bonds for one of three reasons. 1.      They think that the yield is low (around 3%). 2.      They think that the price of the bond will fall if interest rates go up. 3.      They don’t understand them. Now faced with this dilemma I put it to you, do you agree with these 3 points? And if you do agree and it’s the reason why you haven’t considered buying bonds yourself then be ready to be shocked because this could be a game changer for you. That’s because whilst each of these statements may have some truth in them they shouldn’t stop you from investing and making good money in bonds. Allow me to address each point individually. Firstly, it’s not true that the yields on all bonds arels low because that is such a sweeping statement. It’s like saying that all houses are expensive or that all shares are risky. It’s simply not true. Whilst it is true that generally speaking most bonds don’t offer fantastic yields, that is not to say that there are not some which do. It’s just a case of rolling your sleeves up, doing the research and finding them. And it’s not always the case that those bonds paying high yields are high risk. Remember a bond yield is reflected by the price and prices can and do move. So sometimes a bond price fall can trigger a temporary increase in the yield. The same thing happens with shares, when the price falls the dividend yield increases. Whilst bonds are clearly not volatile in the same way that shares are, they can still move. For example, I recently saw a bond from Aviva offering a yield to maturity of around 5.5%. Crazy, right? At the same time that millions of investors are crying into the cereal bowls because they earn 0.1% on their cash savings, one of the largest insurance companies in the UK is throwing money at them at 5.5%. So, let’s move to point 2, interest rates. That’s right interest rates will affect the price of the bond but quite frankly, who cares? Yes, you heard me correctly, who cares. Interest rates only affect the price temporarily and as long as you hold the bond to maturity i.e. when it redeems, then you are guaranteed to get back a price of par (100). In other words, interest rates only affect the investor if you are buying a long-dated bond that you don’t plan to hold until it matures. If you buy a bond that has a remaining shelf-life of say 3 years and provided that you don’t need to sell the bond before this date, then you have no risk of price. The last point I absolutely do agree with. Most retail investors just don’t understand bonds and the professionals don’t seem to want you to invest in them. I can only imagine this is because if you buy a single bond direct from source then there is no annual fee for the advisor, but let’s park that discussion for another time. The fact is that if you don’t know how bonds work then you should learn. They are simple tools, they are lower risk than shares and right now they are sat perfectly wedged between cash and equities. The capital is guaranteed (provided the bond issuer doesn’t go bust), they rank much higher on the creditor list than ordinary shareholders in the event of default and unlike shares you know exactly what you are getting. There is no risk of uncertainty as you get with shares. Just think about it for a second. If you are scratching around getting a measly 1.5% on your cash ISA (which is actually below inflation and so in real terms you would be losing money) would it not make sense to earn 3 times that amount in a fixed income investment? I would think so. But even if this is not the case you should still do the maths and work out for yourself. As always, this short article is not investment advice and I don’t want you running out and buying the next bond that you see. There are things that you need to know but knowledge is power and if you don’t want to constantly have your trousers pulled down to your ankles by the banks then you need to arm yourself with lots of knowledge (or you could just buy a better belt).